Pierre Gerard, Scorechain CEO, wrote an article for the first edition of the TOKENS Magazine by Société Générale Securities Services (SGSS) about Switching Back to Fiat. To see the original article published by SGSS, please see the online version of TOKEN Magazine here: http://online.fliphtml5.com/yvfy/aooz/ (our article is on page 37).
To be a real success, the Blockchain innovation that brought tokens and crypto-assets will need an integration within the existing financial worlds. Pure players or crypto startups need to fulfill the regulation’s requirements to integrate their digital assets in the economy and financial institutions will be able to interact with these new assets only when the regulation will be clear. The last bills adopted in France and Luxembourg are for instance the first pillars of this evolution.
Today, more and more banks are interested in getting customers coming from this new ecosystem. Companies that have done a successful ICO – initial coin offering – need to open an account to pay salaries and suppliers, crypto millionaires who want to cash out to buy a home have to follow onboarding process and follow the compliance policy of the banks.
The same rules as in the FIAT world apply to the crypto world: after the traditional KYC – know your customer – process, the bank has to verify the origin of funds and do AML (anti money laundering) and CTF (counter terrorist financing) checks. These rules have been specified directly for cryptocurrencies. The 5th Anti-Money Laundering Directive, has directly addressed the cryptocurrency regulation, with new AML and CTF obligations, also called KYT – know your transaction.
Transactions done in a Blockchain – for instance for Bitcoin – are public but pseudonymous as no names are stored in the Blockchain and only addresses are seen. Some tools from companies like Scorechain and other competitors provide powerful analytics to track transactions and group addresses – called clusters -, giving very useful data to analyse on-chain activity and verify the origin of funds as stated by the customer. However, things are not quite that “easy” as there could be a lot of interactions with off-chain transactions.
Let’s take the example of a person who wants to transfer 1M€, saying this money is coming from the sale of 250 Bitcoin with an average value of 4000€, what would be the onboarding process that the compliance officer would need to run in order to accept this fund?
Bitcoins can come from several sources like legit activities ie trading, mining or earning (payment for a legal service) and of course from illegal or undeclared activities (like sales of forbidden goods in the darknet or ransomware).
If the customer has traded coins on an exchange, for instance he has invested 1000€ three years ago and sold the coins later with a gain of 10x, he has to show the bank transfer corresponding to the 1000€ investment from his bank account to the exchange and the transactions log of the trades he did via the exchange, this could be very complex if he has traded in different cryptocurrencies or tokens in between.
Depending on the tax rules that apply to the customer, he might also be requested to prove that all the tax declarations have been made and paid.
If the coins have been moved from wallets to wallets, we should also verify that these wallets were owned by the customer and ask him to sign the private key of the wallets and prove the ownerships.
Again, advanced Blockchain explorers can follow all the transaction flow, detect wallets and display interactions with other exchanges or services like mixing.
In the case of Bitcoin coming from mining, it’s quite easy to trace the origin of coins as they appear as a reward in the block of transaction as pure new issued coins. This is valid for individual mining but can be more difficult to verify if it comes from mining pools or mining services in which the user does not really get the new coins but a part of the mining reward which can come from a wallet owned by the service. In this case, additional checks need to be run to analyse the mining activities.
Another possible source of coins is the payment for goods or services, then we have to check the payment with the corresponding invoices or order forms, verify if any applicable VAT was computed and paid, if the value of the goods or the services is right – based on historical exchange rate with Fiat currency. It could also be necessary to check that the service or the good has been effectively provided.
But the mission of the compliance department consists in fact in the verification of the story told by a customer rather than trying to find the origin of funds without any information from its customers. The department has to verify off-chain documents and on-chain data and see how they match, then, depending on the risk level, decide if the customer funds are accepted.
Finally, the compliance should not stop after the onboarding is done, ongoing monitoring of the wallets could be necessary, the customer could have shown some transactions during the onboarding process to validate some coins and switch funds during the cash out operations if they are done during a long period. For instance, Scorechain proposes the creation of automated alerts that can be triggered if new transactions are detected or if there is a modification of the risk scoring of the wallets.
Today, the first banks are implementing these new processes, they have to understand all the new transactions flows, to define new procedures that mixed on-chain and off-chain activities and to integrate them in the existing infrastructure. The arrival of stable coins is also a new step that will facilitate the interaction of the crypto assets in the traditional finance.
For more information about SGSS, check: https://www.securities-services.societegenerale.com/en/